Tag Archives: deflation

Banks can loan out 90% of all of their deposits. Investments banks and many other financial institutions can invest 100% of their deposits. What has happened recently is that the banks and other financial institutions have been investing in each other and artificially inflating the value of their capital.

Just imaging the effect of a well regulated bank taking 90% of its deposits and redepositing that money in a neighboring bank. And that bank, in turn, does the same thing back to the first bank. The apparent capital of a commercial bank, then, can be extremely inflated. This effect has been even more extreme in other financial institutions. More ‘fake’ capital, (money), has also been generated in a similar way by financial markets and by the new fangled products that traded there. The result is a lot of ‘paper’ wealth has been generated and used as collateral for investing in ‘real’ wealth; such as real estate.

Now, that fake money has evaporated leaving everyone with more debt than real money. The result is deflation; the value of money increases compared to the value of other property. In other words, a dollar can buy more tomorrow than it can buy today. That is why the trillions of dollars injected into the economy by the government are not yet causing inflation. Those cash injections are only filling in the void left by the evaporation of the fake money.

But governments are clumsy managers. Chances are they will inject cash until the economy has recovered enough to inspire businesses to spend again. And for reasons stated in other parts of this blog, that will is going to take an exteded period of time. By then businesses would have hoarded so much cash that they will go on a spending spree. This, combined with all of the other cash injected by the government, will inevitably inject too much cash into the economy.